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The Situation of Credit Card Regulation

Situationist Contributor Adam Benforado recently published the following op-ed, titled “Time to Rein in Tricks of the Financial Trade,” in Cap Times.

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I have a confession: I teach contract law, and I do not understand everything in my credit card agreement.

If business law professors are getting lost in the fine print of consumer financial products, we have a fundamental problem.

Back in the early 1980s, the average credit card contract filled up a single page. Today, a similar agreement runs to more than 30. These contracts are designed to maximize company profits by hiding costly traps for consumers in a dense forest of confusing provisions and mysterious words like “LIBOR” and “Cash Equivalent Transactions.”

It is no wonder that a 2006 study by the Government Accountability Office found that “the disclosures in the customer solicitation materials and card member agreements provided by four of the largest credit card issuers were too complicated” and that “many (credit card holders) failed to understand key aspects of their cards, including when they would be charged for late payments or what actions could cause issuers to raise rates.”

Credit card companies defend themselves by explaining that they fully disclose the terms and risks associated with their products, but it is not disclosure if you know that the other party is incapable of understanding the information you are conveying – and particularly if your profitability model is based on that person not understanding.

The situation is really no different than if credit card companies decided to print all of their U.S. contracts in Arabic instead of English. Yes, consumers would technically be given all of the relevant particulars about rates, balance calculations, and payment periods. However, just as here, companies would know that most consumers would not grasp the fundamental provisions of the agreements and that, as a result, the companies could get away with hiding plenty of underhanded – but highly profitable – tricks in the details.

The consumer financial products industry loves to talk about how it works tirelessly to cater to consumer choice, but these incomprehensible documents are a testament to the lack of choice under the current system. Dozens of critical decisions are dictated by the company with no input at all by consumers. Indeed, these contracts – whether credit card agreements, car loans, or mortgage papers – are filled with provisions that few if any rational consumers would choose if they had the option.

What customer would select a universal default provision, permitting a bank to increase interest rates even when that customer is meeting all of the terms of her credit contract? Who, in their right mind, would choose to have double-cycle billing, allowing companies to charge interest on money that a customer has already repaid? Who would elect to give the opposing party in an agreement the right to change the terms of the contract at any time, for any reason, while binding himself to follow every little detail?

The current system is not about maximizing customer choice; it is about maximizing profit while constraining choice. By strapping customers into contractual straightjackets, credit card companies can reach their hands into Americans’ back pockets without much effort at all. And that they do: for billions of dollars a year in ill-gotten interest payments, fees, and other credit charges.

So what is to be done?

We need a regulatory agency to protect our freedom of choice and to force companies to provide real disclosures – ones that everyone understands. Though it has not gotten much attention in the press, President Obama recently proposed just such an entity: a Consumer Financial Protection Agency charged with ensuring financial product safety.

Unifying and mending what is now a patchwork quilt of ineffectual, complicated, and contradictory regulations, the CFPA would have the power to set guidelines and monitor mortgages, car and payday loans, and credit card contracts. The agency would work to promote clear explanations of the real risks and costs of financial products in contracts that could be read in three or four minutes without the assistance of a lawyer or an MBA. With this newfound clarity, consumers could knowledgeably compare products and exercise real choice, allowing market competition to work effectively and allowing those honest and fair companies that currently don’t stand a chance to rise to the top.

Just as they have deceived consumers with legalese and fine print, industry representatives are now trying to muddy the waters for policymakers with convoluted arguments, faulty logic, and fear mongering. We must not lose sight of the truth: The CFPA is needed to protect the freedom and economic stability of hard-working American families.

2 Responses to “The Situation of Credit Card Regulation”

Tamara Pietysaid

Great post Adam. I would go further and say not only should such agreements be written in clear and easy to understand language, but that many of the credit card issuers’ marketing practices should be restrained as well. For example, “convenience checks” usually carry high fees and are particularly likely to be used by consumers who are experiencing financial hardship. And although the average user can perhaps simply throw them away, the checks themselves expose the customer to risk of identity theft. When you consider that many people receive several of these solicitations a month (or even a week), that is a lot of paper which must be shredded or run the risk that it be misused. That seems environmentally unsound as well as likely to encourage habits with respect to the use of credit that might be problematic both personally and at the macro level. Increasing customer credit lines, in the absence of a customer request for an increase, merely to increase the amount of spending seems to offer similar problems. Punishing customers who actually use the credit they have been given with higher rates or fees, even though the limits may have been set unreasonably high by the issuer, seems unfair. There are myriad business and marketing practices that are very, very troubling. One would think that reforming the law to require more transparency in the “agreements” themselves would be a relatively minor and unobjectionable request. It is a measure of these companies’ ability, to date, to control much of the debate and the legislative response that such proposals are viewed by some as radical reform. To the contrary it seems only fair, not to mention desirable on the grounds of consistency and efficiency.

Me wonders if moral hazard is also at play whenever someone takes a credit card out of their wallet, given that the person who is making the purchase (self at t=now) is not the same person that’ll pay for the purchase (self at t=future).

I spent half of my career marketing credit card and can assure you that even credit card marketing executives do not understand the intricacies of the very products that they hawk.

I’ve always liked the idea of a borrower’s license that you’d have to have in order to get a credit card.

But then, that doesn’t address the root cause: that people want to buy stuff they can’t sustainably afford.